Analysis: Hungry China links Potash to rice smugglers

BEIJING Mon Aug 30, 2010 12:06pm EDT

1 of 2. A farmer harvests paddy in a field on the outskirts of Xiangfan, Hubei province August 27, 2010. After decades of pursuing self-sufficiency in food production, China is bumping into the limits of that policy and looking abroad more than ever to satisfy its growing appetite. Picture taken August 27.

Credit: Reuters/Stringer

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BEIJING (Reuters) - Rice smuggling out of Vietnam, a rush to book grain barges in the United States and BHP Billiton's $39 billion takeover bid for fertilizer giant Potash Corp -- a common thread runs through them all.

After decades of pursuing self-sufficiency in food production, China is bumping into the limits of that policy and looking abroad more than ever to satisfy its growing appetite.

Much as Chinese demand has driven oil and iron ore prices higher over the past decade, its imports of corn, wheat and rice could become a new force, pressuring up global inflation and giving farmers worldwide fresh incentive to boost output.

"It is inevitable that China will import more grains," said Yu Mengguo, a deputy general manager at Jinpeng International Futures Co. in Beijing.

"Living standards are going up and people need to consume more. What's worse, China has a lack of good land and water."

Scarred by memories of chronic hunger and bouts of devastating famine, China has defied its physical constraints in pursuit of food security over the past three decades.

The government has spent vast sums on irrigation, pest control, grain reserves, the development of hardier crops and bio-technology research. The investment has paid off. With 9 percent of the world's arable land, China has more or less produced enough food for its own people, 21 percent of the world's population.

That is now changing.

China first swung to a deficit in agricultural trade in 2004. Even though the rise in net imports since then has been incremental, this year has given warning that reliance on overseas production will accelerate in the future.

INFLATIONARY PRESSURE?

China is already the world's biggest soy buyer and its demand for grains is picking up. Its agricultural deficit in the first half was $11.3 billion, nearly double that in the same period in 2009.

A drought last year that hurt Chinese corn production is the main reason for the wider gap, but a big jump in corn shipments from the United States -- the most in 15 years -- is a sign of how tight China's domestic supply has become.

In China's south, a shortfall in rice has led buyers to Vietnam. To get round import quotas, they have smuggled in nearly 600,000 tonnes of rice.

Consequences for the global market have been clear enough. Corn prices have risen nearly 25 percent since the start of July, driven by Russia's drought but also supported by sales to China.

Rising Chinese demand will be an inflationary force on a global scale, but in China itself more imports should help prevent food shortages from leading to price spikes and broader inflation as has happened in the past.

"The government is being tolerant toward grain imports this year, partly because cheaper imports can help curb domestic grain prices and hence reduce inflationary risks," said Ma Mingchao, a futures analyst at Qingma Investment.

Rising food costs pushed Chinese inflation to 3.3 percent in July, the highest in 21 months, but the increases are much less pronounced than in 2007 when the country's pig farms were hit by disease and there was no easy import answer to suppress prices.

INVESTMENT BECKONS

As Chinese consumption pushes up global food costs, experts are optimistic that the impact will be mitigated by increased supply.

"The best solution to high prices is high prices," said Scott Rozelle, a Stanford University professor and leading researcher in Chinese agriculture.

Fatter profits will induce more spending on technology and better use of land. Nevertheless, global food prices are still set for a steady upward drift that will present opportunities and challenges, he said.

"It's fantastic for the poor if you're a farmer with land," Rozelle said. "It won't be an easy time for countries with big, poor urban populations."

Given the China effect, buying long-dated commodity futures is a good way to bet on rising demand, said Guillermo Felices, a strategist with Citigroup in London.

Global miner BHP Billiton's bid for Potash, the world's leading fertilizer company, must also be seen in this light, he said.

"It essentially means that cash-rich companies want to invest in resources that are linked to food," he said. "That's a fairly bullish signal about what these people expect for demand for agricultural products."

(Additional reporting by Zheng Xiaolu; Editing by Tomasz Janowski)

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